Spotify Hits 10 Million Paid Users. Now Can It Make Money?
By Joshua Brustein May 21, 2014
Spotify CEO Daniel EkDaniel Ek has devoted most of his waking moments over the past few years to evangelizing about the glories of streaming music. He’s well suited to the task. In addition to a forbiddingly deep reservoir of knowledge about every genre and subgenre to emerge from his native Sweden, Ek, 31, is the co-founder and chief executive of Spotify, the first company to make streaming so easy that downloads quake in its presence.
Competition was inevitable in such a popular space, but when Beats Electronics launched its own subscription service, Beats Music, in January, it seemed more like a validation of Spotify’s model than a threat. The two companies offer the same basic service: a $10-a-month subscription that gives users the ability to stream songs from the company’s servers. Beats, started by Jimmy Iovine and Dr. Dre, doesn’t offer a free version, whereas Spotify has one supported by ads. The music industry, weary from decades of being tortured by consumers, has greeted streaming with skepticism. But in its tradition of acquiescing to the latest consumer demand and asking questions later, it’s also signed enough deals to make Spotify’s library pretty comprehensive.
Spotify will announce today its 10 millionth paying subscriber, and an additional 30 million people listen for free. Ek says that as long as Spotify accomplishes its main task—getting people to stream more music—free users will continue to upgrade to paid subscriptions. “We know if you do that, you’re going to be like, ‘Hey, 10 bucks is nothing. It’s like two beers,’” he says. “In Sweden, it’s actually less than one beer.”
But the abundant reports (still unconfirmed) that Beats is close to signing a $3.2 billion deal to sell itself to Apple (AAPL) have cast doubt on the inevitability of Spotify’s rise. A union with Apple could go a long way toward boosting the subscriber base of Beats Music and potentially transform the market for streaming services. (Beats didn’t respond to a request for comment, but estimates of its user base range from 110,000 to 200,000.) All of this puts more pressure on Spotify, which has been great at getting people to pay for subscriptions—and not at all successful at turning a profit.
Scale is a magic word for so many cloud-based companies and services, but Beats and Spotify operate differently. Their margins don’t improve as they get larger. If Spotify bought the rights to songs for a flat rate, then every subscriber it adds would mean free money for the company. But that isn’t what it does. Instead, it spends a fixed proportion of its total revenue on royalties. So if Spotify doubles its subscriber base, it doubles the amount of money it pays out. It may be that Spotify will gain some power over the royalties it pays once it has a critical mass of customers, but right now, many people think it can never get ahead of its costs.
The worst-case scenario for Spotify isn’t losing to Apple. It’s discovering that its prize is insolvency. According to a report published by Generator Research last November, the current business model for streaming music is “inherently unprofitable.” Andrew Sheehy, the main author of the report, concluded: “Our analysis is that no current music subscription service—including marquee brands like Pandora, Spotify, and Rhapsody—can ever be profitable, even if they execute perfectly.”
Spotify has lost a total of $200 million since it was founded, according to a report last year based on its financial disclosures written by PrivCo, a firm that studies private company performance. Spotify declined to discuss its balance sheet.
The company does say its contracts are structured so about 70 percent of its revenue goes to royalties; any other costs of business have to be covered by what remains. In